Lawyer’s View: CMBS

Cadwalader has provided lead counsel services in several of the largest single-borrower CMBS transactions ever. What kinds of challenges have those deals presented?

This year, we did a $2.5 billion deal representing J.P. Morgan, involving the hotel chain Extended Stay of America. From a legal perspective, these big, private CMBS transactions often involve complicated structures and sophisticated investors. Some of the complexity lies in the structuring of the securities and some in coming up with the disclosures for the risks associated with the transaction. Of course, what precedes that is the complex structuring of the loan itself.

The J.P. Morgan-Extended Stay deal had multiple fixed and floating-rate components of the loan with varying maturities that had to be securitized, and a very complicated cash flow structure. That deal was reminiscent of a deal we did in 2001 representing Lehman Brothers and Goldman Sachs involving the retail mall company General Growth Properties, also a $2.5 billion deal, which at that time was the largest CMBS deal we had done. The 2001 deal closed soon after 9/11, so one of the big issues was terrorism insurance. It was a challenge, but the deal got done.

In the first two months of the year, commercial mortgage-backed security lending jumped to $21 billion, about four times the volume of 2012’s first quarter. What does your client work tell you about where the market is headed?

I think it’s slowed down a bit, but the trajectory is good. The volatility in the bond market after the Federal Reserve announced the possibility of tapering stimulus efforts led to a slowdown in originations. It also led to a difficult environment for the sale of securities. But since the Fed dialed back some of that concern, I think things have settled down a bit. If I look at the level of activity in our capital markets department, we’re not exactly where we were in the first half of the year, but it’s still going to be a strong year overall—certainly compared to the past four or five.

Have the legal procedures and requirements for CMBS loan originations changed from the market collapse in mid-2008 to now? How so?

Fortunately, we have gone through a period in which we helped to develop and enhance the structures and procedures in CMBS 2.0. When CMBS 2.0 came back, we represented Goldman Sachs in the first deal, a Developers Diversified deal which was also a deal where the Fed provided TALF financing. That was a seminal deal for CMBS 2.0, and many of its key features are being replicated now in other CMBS deals.

Now we’re seeing more of a desire for securitized mezzanine loans, so, instead of having the loans issued in loan form, we’ve focused on having them issued in security form. A number of the deals we’re working on now involve the securitization of a single loan, which could be backed by multiple properties, as well as the securitization of the most senior mezzanine loan in a stack of mezzanine loans. With that, you have certain control rights and consent rights given to the mezzanine lender and others that are in the hands of the mortgage lender.

With all of these new CMBS deal-making techniques, has there been more scrutiny from regulators?

We’re not talking about the residential market here, but, to the extent that you’re dealing with a regulated institution originating loans, there’s certainly more focus on that. You also have the overall Dodd-Frank rules that have been promulgated but have yet to be implemented in some respects—for example, the concept of risk retention, which would require the originator to retain a portion of the risk associated with originating a loan. That will come into effect at some point but not until two years after the final rules are adopted.

There were other requirements imposed under Dodd-Frank that we have had to deal with, such as reporting on breaches of representation and warranties relating to underlying assets. There’s now a reporting regime and a disclosure regime. Other rules that now apply include periodic reporting for public deals throughout the life of the deal, as well as disclosure obligations, such as disclosing the securitization process by which the sponsor verifies that any information in the prospectus is accurate.